Remittances, Real Effective Exchange, and Monetary Policy

Alexei Kireyev, IMF

Денежные переводы, реальный эффективный валютный курс и денежно-кредитная политика

Roadmap

1. Macroeconomics of remittances2. The impact on REER3. Monetary policy response4. International experience5. Conclusions

1. Remittances differ from other types of inflows, in particular aid

Remittances and the aggregate demand

Y=(C+I)p+(C+I)g+(X-M+NY+NCT)

Private sector balance

Remittances are included in factor income (NY) and net current transfers (NCT). Call remittances R, other things being equal

Current account (CAB)

Trade balancePublic sector balance

Income

Macroeconomic implications of remittances depend on

• Their use: consumption, saving or investment• Their size relative to other balance of payment

flows• Degree of their volatility• Their persistency: shock or a constant flow.

Impact of remittances on money supply and exchange rate

Case 1Case 2 Case 3

Case 1. Remittances saved

Case 2. Remittances spent on consumption

Case 3. Remittances invested

The overall macro impact is mixed• No impact on money supply if saved outside banks;

spent on imports or invested abroad• Increase in money supply if saved in banks in local or

foreign currency; spent on consumption in local currency.

• No impact on the exchange rate if saved in banks and outside banks in foreign currency; sent on imports, invested abroad or locally in foreign currency

• Upward pressure on the exchange rate if saved in local currency in banks and outside banks; spent on consumption of local goods and services; and invested at home in local currency

2. Real effective exchange rate

Channels for REER appreciation

• Under a fixed exchange rate regime: inflation in non-traded goods and services

• Under a flexible exchange rate regime: nominal exchange rate appreciation and some inflation in non-traded goods and services.

Volatility of remittances

Capital mobilityIneffective monetary policy

Effective monetary policy

Flexible exchange rate

Fixed exchange rate

Trilemma

3. Monetary policy response

Constraints for monetary policy response to remittances

Options for monetary policy in case of REER appreciation

In case of a shock from remittances and a disruptive REER appreciation

• resist nominal appreciation: intervene by purchasing foreign exchange to reserves

• resist inflation in non-tradables: – sterilize money supply by selling securities– increase reserve requirements, part in foreign exchange – raise policy interest rates

In case of a permanent flow of remittances and an orderly REER appreciation

• do not intervene against fundamental trends• smooth extreme volatility of the nominal exchange rate by two-

sided interventions• allow the nominal exchange rate adjust

Shortcomings of an active monetary policies in response to REER appreciation• Sterilization increases interest rates and

therefore attacks addition foreign capital and accelerated REER appreciation

• High interest rates and tight liquidity deprive the economy of the benefits of remittances inflow by hampering investment and growth

• Sterilization can be costly to the Central Bank and discourage financial intermediation.

REER appreciation is unlikely and monetary policy response may not be needed at all if• remittances are predominantly spent on

tradables (imports or transferred in kind)• inflow of remittances leads to reduced

interest rate on external borrowing (if external creditors consider remittances as part of country’s wealth)

• remittances is and established component of the current account and allow to suitably finance part of the trade deficit.

4. International experienceHave remittances actually led to the REER appreciation in some

country?• Yes: Cape Verde(Bourdet, 2003), Pakistan (Hyder, 2005), Jordan

(Petri, 2006), Dominican Rep, El Salvador, Guatemala (Izquierdo, 2006), panel of 13 LA countries (Amuedo, 2004)

• No: Honduras, Jamaica, Nicaragua (Izquierdo, 2006) , sample of 15 Latin American countries (Rajan, 2005).

Have the authorities actually undertaken active monetary policy measure in response to remittances?

• Yes: El Salvador with mixed results, developing countries at large (Calvo et al., 1996)

• No: Mexico (Riuz, 208), Tajikistan (Kireyev, 2006), seven Latin Amrican countries (Ball et al, 2009)

Remittances influence the choice of the exchange rate regime (Singer, 2010)

5. Conclusions• Impulsive and cyclical remittances may present significant

challenges for macroeconomic management by destabilizing money supply and leading to REER appreciation above the equilibrium level. Active monetary policy is appropriate with the view to resist temporary REER appreciation in this case.

• Orderly remittances, already included in the economic structure of receiving economy, should be treated as any other regular inflows, lead to a more appreciated level of the equilibrium REER, and generally do not pose problems for macroeconomic management. Active monetary policy is not needed in this case.

• International evidences on whether remittances have posed serious problems for monetary and exchange rate policies are mixed but generally point to the fact the some REER appreciation should be expected.